7/15/2010 @ 5:10PM

Conflicts Of Interest Common In Estate Planning

Lawyers’ code of professional responsibility forbids them from handling matters in which they have a conflict of interest. But conflicts of interest are common in legal practice and nowhere are they more common than in estate planning. Here are some examples I’ve seen in my 25 years of practice.

Feeding Frenzy

One conflict that has troubled me from the beginning of my career involves the designation of fiduciaries in estate planning documents. Here’s how it works: A lawyer accepts estate planning referrals from a bank. Then, pursuant to an unwritten (wink, wink) understanding with that bank, the lawyer draws up documents appointing the bank as fiduciary of the client’s trust(s).

If a client questions this, the lawyer rationalizes naming the bank on the grounds that a bank is better able to manage a trust and its assets than an individual. So the bank’s appointment takes effect upon the client’s death. The bank then appoints itself as investment advisor to the trust, receiving an annual management fee for being the trustee, as well as commissions for investing the trust’s funds. The bank also receives hourly fees for such services as preparing tax returns for the trust and for the decedent’s estate. The bank makes money coming and going. And whom do you suppose the bank retains as the trustee’s counsel? That’s right, the bank’s pal, the drafting attorney. And the person who earned the assets held by the trust and who would most care about those assets–the testator–is dead. So the bank and the drafting attorney aren’t likely to get much resistance to their cabal.

I recommend that clients name a succession of family members or other trusted individuals to serve as trustee. It makes sense to name a bank to serve as trustee in the event none of the individuals named is able to serve. A bank can also make sense as trustee of a disabled individual. I don’t get many referrals from banks.

Pigs At The Trough

I have also seen estate planning documents naming the drafting attorney as trustee/executor, or as counsel for the trustee/executor. Such a provision is unethical, unless the client is made aware of the provision and consents to it.

Who Is the Lawyer’s Client?

Elderly, vulnerable individuals are also at risk for conflicts of interest. These individuals tend to be lonely and have mounting health issues. (For advice on how to protect your aging parents from financial fraud, click here.)

In one case, I planned a woman’s estate and later she was diagnosed with cancer. Meanwhile, her son-in-law had discovered that she had assets. The son-in-law brought the woman to his attorney, who advised the woman to transfer her property to her daughter and son-in-law, “so that the government won’t get it.” However, for Medicaid qualification purposes, an individual who gives away property is deemed to continue owning it for five years. In other words, the woman would have to give away her assets, becoming destitute, and remain destitute for five years. Only then would she qualify for government-paid Medicaid nursing care. The woman had worked all her life to accumulate her estate, it should have been used to make her as comfortable as possible in her remaining time. The woman died before the son-in-law and his attorney could execute their designs on her assets.

In another case, after a woman’s husband had died, she fell and suffered a stroke and the onset of dementia. She also had long suffered from leukemia. A neighbor lady saw opportunity in the woman’s vulnerability. The neighbor began spending more and more time around the woman, working her way into the woman’s confidences. The woman’s estate plan, prepared shortly after her husband’s death, had bequeathed her estate to four charities. Eventually the neighbor persuaded the woman to see the neighbor’s attorney, who drew a new set of estate planning documents for the woman cutting out the four charities and leaving her estate to, you guessed it, the interested neighbor.

The woman’s internist testified that he had seen her shortly before she visited the neighbor’s attorney. The Internist testified that he administered a mini mental status exam to her, which she failed woefully. The internist had noted that the woman had become increasingly lonely and depressed since the death of her husband, and that at times she was tearful in the Internist’s office.

The woman’s hematologist saw her shortly after she signed the purported revised estate planning documents. He noted that it was apparent from looking at the woman that she was disoriented and confused.

I sued the interloping neighbor on behalf of the four disinherited charities, and recovered a substantial amount for them.

Conflicts In Trust Funding

Property that an individual owns at his or her death must be retitled in the names of successors entitled to it by law. This retitling is the judicial process of probate. Probate is to be avoided for many reasons–it is an expensive, public proceeding in which claimants are invited to assert claims against the estate. Moreover, probate delays distribution of an estate.

The best way to avoid probate is to establish a revocable trust and transfer your property to it during your lifetime. Then, at your death, the trust becomes irrevocable, and the trust is administered according to your trust document. There is no probate estate.

In the case of a married couple with substantial marital property, each spouse should have a revocable trust, and the spouses should seek to equalize the marital property in their respective revocable trusts. “Marital property” means assets earned by the spouses or either of them during their marriage, and excludes assets brought by either of them to the marriage, assets received by either of them by gift or inheritance during the marriage, or assets covered by a prenuptial agreement; provided, however, that non-marital property can become marital property if it is commingled with marital property.

Over the years many business owners have asked me for an estate plan that funds the business–and perhaps all of the marital property–into the husband/business owner’s trust. The issue seems to be control as well as concern about what would happen in the event of divorce.

Unequal funding of spouses’ revocable trusts could substantially increase the estate tax on succession to the couple’s property (trust me on this). Moreover, in the event of a divorce, the divorce court would marshal the couple’s marital property, including such property held in revocable trusts, and divide it equitably–equally–between the spouses. Finally, upon the death of the spouse with an underfunded trust or without a trust, her estate could sue the surviving spouse claiming that the unequal funding of marital property into the revocable trusts was in fraud of her marital rights.

Where a proposed estate plan will unequally fund the couple’s marital property into their revocable trusts, the spouse whose trust will receive the lesser amount of property should be referred to separate estate planning counsel.

Stephen (Steve) J. Dunn, C.P.A., J.D., LLM, is a tax attorney and Of Counsel with the Demorest Law Firm, PLLC, Birmingham, MI., an adjunct lecturer in the University of Michigan-Dearborn College of Business, and an author. He represents taxpayers in both civil and criminal tax matters and plans and administers estates for small business owners and others. Write to him at steve@demolaw.com.